Abstract
Textbook arbitrage in financial markets requires no capital and entails no risk. In reality, almost all arbitrage requires capital and is typically risky. Often the perceived arbitrage opportunity is based on a number of assumptions with a degree of risk underlying these assumptions. Should any of these assumptions regarding market behaviour not materialise during the lifespan of the arbitrage position, varying degrees of risk are assumed. This study was undertaken to assess whether financial markets can still be profitably exploited through arbitrage trading.
As far as possible South African currency (Rand) and securities - representing an emerging market environment - are incorporated into this study. Whereas many previous studies on the profitability of arbitrage trading are based on market closing prices or intra-day sampling rates of thirty minutes or longer, the greater part of this study was conducted - using real-time price data. Furthermore this study also ventured beyond the numerous and convenient simplifying assumptions, typical of most studies on the subject of arbitrage, to obtain a better assessment of real world arbitrage margins.
The results of this study portray the financial markets as very efficient with very limited arbitrage opportunities available in the traditional deterministic arbitrage trade-rule environment. The heuristic arbitrage trade rule, however, offers significant profit opportunities above the risk-free rate of return.
Notes
1 No transaction costs, no holding and transportation costs, no taxes and complete certainty
2 Assuming the same maturity and strike price
3 Tick size = minimum increment by which share price can change
4 or next business day if third Thursday is a bank holiday
5 Assuming no transaction cost, no taxes and complete certainty